Edited version of private ruling

Authorisation Number: 1011696620364

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Ruling

Subject: continuity of ownership test

Will the transfer of shares originally owned by a shareholder to beneficiaries of the Estate of their spouse cause the company to fail the continuity of ownership test in section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

1 July 2010 - 30 June 2011

The scheme commences on:

1 July 2003

Relevant facts and circumstances

Several years ago, the shareholder passed away. Their spouse was the sole beneficiary of the estate.

At the time of death the shareholder owned more than 50% of the ordinary shares in the company.

Ordinary shares in the company have voting rights, the rights to dividends and ranks third behind class B preference shares and Non-cumulative redeemable preference shares in the rights to capital distributions.

The company became the head company of a consolidated group sometime thereafter. At this time the estate of the shareholder owned more than 50% of the shares in the company (the shares).

You have stated that at consolidation the continuity of ownership rules were satisfied and all losses were transferred to the company

Some years later, the spouse passed away. Probate for the estate of the shareholder had not been granted at this time.

The company recorded tax losses.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1997 section 165 -12

Income Tax Assessment Act 1997 section 165 -13

Income Tax Assessment Act 1997 section 165 -70

Income Tax Assessment Act 1997 section 165 -205

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for Decision

Unless indicated all legislative references are to the Income Tax Assessment Act 1997.

Section 165-10 states that a company cannot deduct a tax loss unless either it meets the conditions set out in either section 165-12 (continuity of ownership test) or in section 165-13 (same business test).

You meet the conditions set out is section 165-12 if during the ownership test period there are persons who;

(i) had more than 50% of the voting rights in the company; or

(ii) had rights to more than 50% of the company's dividends; or

(iii) had rights to more than 50% of the company's capital distributions.

The ownership test period is the period from the start of the loss year to the end of the income year. A loss year is determined by working out the company's tax loss in accordance with section 165-70.

Section 165-205 states;

For the purposes of the test, after a person dies, shares that the person owned beneficially at the time of death are taken to continue to be owned beneficially by the person so long as:

a) they are owned by the trustee of the person's estate; or

b) they are owned beneficially by someone who received them as a beneficiary of the estate.

Application at the time of the death of the shareholder

At the time of death the shareholder beneficially owned more than 50% of the ordinary shares in the company.

Under State laws governing succession of property title in the property of a deceased vests automatically in the executor of the deceased's estate by operation of the doctrine of 'relation back'.

Under section 165-205 the shareholder is taken to continue to beneficially own the shares so long as they are owned by the trustee of their estate. The term trustee is defined in sub section 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and includes executor of an estate.

For the purpose of the continuity of ownership test the shareholder is taken to have continued to own the shares beneficially at the time of their death.

Application at the time of the death of the spouse

At the time of the death of the spouse all of their rights established under the will of the shareholder passed to their estate. As the estate was yet to be finalised, the trustee of the shareholder continued to own the assets of the estate and the shareholder is taken to have continued to have beneficially owned the shares in the company.

However, in Commissioner of Stamp Duties (QLD) v. Livingston [1965] AC 694; [1964] 3 All ER 692 Mrs Coulson was the residuary legatee of her husband's estate, she died while her husband's estate was still being administered.

It was held by the Privy Council that equity did not recognise or create for residuary legatees a beneficial interest in the assets during the course of administration.

(W)hatever property came to the executor virtute officii came to him in full ownership, without the distinction between legal and equitable interests.

This view is confirmed in Taxation Ruling IT 2622 a ruling that relates to present entitlement during the stages of administration.

At paragraph 3 the ruling explains the rights of a beneficiary in relation to the assets of an estate in administration;

Beneficiaries of the estate have no interest in the assets of the estate, although they do have a beneficial right to see that the estate is properly administered.

Paragraph 4 states;

Even though a will may provide beneficiaries with absolute and indefeasible interest in the capital or income of an estate, under State laws those interest cannot crystallize until probate has been granted.

As administration of the estate of shareholder had not been completed, the spouse did not beneficially own the shares at the time of their death and section 165-205 would not apply to their ownership interest.

Application when the administration of the estate of the shareholder is complete

When the estate of the shareholder is administered, beneficial ownership will pass to the estate of the spouse. Under section 165-205, the shareholder is taken to continue to beneficially own the shares at this point because the estate of the spouse received them as a beneficiary of the estate. This satisfies the beneficial ownership element under paragraph 165-205 (b).

Application when the administration of the estate of the spouse is complete

When the administration of the estate of spouse is completed the beneficiaries of the estate of the spouse will beneficially own the shares, however they did not received them as a beneficiaries of the estate of the shareholder as required under section 165-205. Rather, they received them as beneficiaries of the estate of the spouse. At this point section 165-205 does not apply and the shareholder is not taken to have beneficial ownership of the shares for the purposes of the continuity of ownership test.

NB. As stated previously the spouse never beneficially owned the shares. Accordingly, section 165-205 cannot apply in relation to their interest in the shares

Conclusion

The ownership test period began after consolidation. At this time the estate of the shareholder owned over 85% of the ordinary shares in the company. When the shares pass to the beneficiaries of the spouse, the shareholder will no longer be taken to be the beneficial owner of these shares under section 165-205. Therefore more than 50% of the shares in the company will have changed ownership under section 165-12 and the company will fail the continuity of ownership test.